How relevant are the “Mutual Fund Ratings”?

 

 

Today, you, a mutual fund investor are overwhelmed with the plethora of mutual fund schemes. More so when you find that schemes from different fund houses come with similar flavours. It becomes extremely difficult for you actually to sift the bad ones from the good ones. Then what do you do?

You take help of rating of mutual funds issued by various mutual fund rating agencies, such as Morningstar, Value Research and ICRA. CARE and CRISIL also rank mutual fund schemes. But is ‘mutual fund ratings’ the final parameter to be taken in to consideration for investment?

 

What is Mutual Fund Rating?

 

Mutual fund rating agencies generally rate mutual funds based on the fund's past performance, the fund manager's skill, risk- and cost-adjusted returns, and performance consistency.

These mutual fund ratings are designed to help investors quickly identify mutual funds to consider purchasing for their investment portfolios.

 

Do better mutual fund ratings mean better returns?

 

Mutual fund ratings by themselves do not guarantee better returns in the future. However, over a period of time better rated mutual funds do perform better than the lower rated ones. But there are always exceptions. Sometimes, lower rated mutual fund schemes may outperform higher rated ones. The chances of a 5 star rated mutual fund going out of rating is very low compared to a 1-2 star rated one.

 

Mutual Fund Ratings: A Backward-looking Mechanism

 

Mutual fund ratings are intended to be a starting point for further research and are not buy or sell recommendations. However, these mutual fund rating suffer one severe limitation that they are a backward-looking assessment mechanism, which does not reflect the rating agency's opinion of the future potential of a fund.

 

Mutual Fund Rating agencies also suggest that their mutual fund ratings look backwards and since past performance is no guarantee for the future, they should be considered only as a filtering mechanism in the process of selecting a mutual fund.

 

Mutual Fund Ratings and Financial Goals:

 

Mutual fund ratings are generic. As an investor you should not invest in all top rated funds. We don’t go to a pharmacy and ask for the best medicines. We need to choose medicine based on our requirement.

 

Similarly, you need to choose mutual fund categories which will help you meet your financial goals. Then in that category of mutual funds, you can look out for top rated mutual funds.

Choosing a suitable category of mutual fund (equity diversified, balanced, income) should take precedence over the search for mutual fund rating. The mutual fund rating would be of no use if one chooses an inappropriate category in the first place.

 

Beyond Mutual Fund Ratings:

 

Experts in the field say that mutual fund rating alone cannot be used as a tool for decision-making while investing in a mutual fund.

One must also look at the ,

·         Ability and stability of the fund house,

·         Track Record and Retention of the fund manager

·         Strong internal investment process

·         Integrity of the mutual fund house.

 

Mutual fund ratings serve as a foundation for you on which to base your search, but should not be used as a benchmark. You have to exercise more due diligence to select the right mutual fund.

The mutual fund ratings primarily help avoid the lousy funds as indicated by the lower mutual fund ratings. You should not, therefore, take a short sighted view on mutual fund ratings and take into consideration other important factors like consistent performance, expenses, fund manager's track record and experience as well as the fund house reputation.

 

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company. 

 

What you need to know about Floating Rate Mutual Funds?

In school, our hearts warmed with happiness when our grades turned out to be better than expected. The same surge of happiness touch us when we are awarded an out of turn promotion at work, win a sports match which we are close to losing, or are rewarded with a higher raise in salary than others. In the world of investments too this happiness can be experienced from certain kinds of investment options.

Unlike the equity funds, debt funds provide conservative returns to its investors. All the same, it is the ardent wish of every investor to gain something extra from their investments. If only the fixed deposit (FD) would give us a higher return whenever the interest rates experience a high. That is not to be, because investments made in FD will only provided fixed returns as promised in the beginning.

What is a Floating Rate Mutual Fund?

Investors can now look upto better investment avenues than FDs, however. Floating Rate Mutual Funds are here to provide that experience and thrill of getting beyond expectation. Basically Floating Rate Mutual Funds are Debt mutual funds, which invest between 75% and 100% of the corpus in securities offering a floating rate interest payout. Bonds, bank loans and miscellaneous debt securities usually constitute this part while the rest is vested in fixed income securities.

Types of Floating Rate Mutual Fund:

Investors can choose from two types of floating rate funds- short term and long term funds. As the name signifies, the former is skewed towards low maturity period with higher liquidity and the later is less liquid and are characterized by long-term maturity schedules.

How Floating Rate Mutual Funds are different?

Unlike fixed security bonds, in the case of floating rate funds, the interest rate can go either up or down depending on the market position. In case of fixed rate funds there is no chance of getting higher returns when the interest rates go up but it is assured that the interest return will not go down. As compared to this floating rate funds can be extremely benevolent if the market is experiencing a good phase, however the possibility of lower returns also exists at the same time.

Certain floating rate fund schemes may experience a daily or monthly rate change, for others it may vary quarterly, annually or even after specific intervals. The interest rates are changed to be in sync with the benchmark rate which is referred to as “Reference Rate”. 

Floating Rate Mutual Funds and Interest Rate Risk:

Debt funds face this interest rate risk. Whenever, the interest rates go up, the debt funds’ nav will go down and it results in temporary loss to the investors. This interest rate risk is not there in floating rate mutual funds because they invest in floating rate papers.

Why Floating Rate Mutual Funds?

So, why should the investor opt for a Floating Rate Mutual Fund? Well here are a few good reasons for doing so:

I.                    Lower volatility as compared to other debt funds.

II.                  Floating rate funds have been seen to deliver very good returns in a consistent manner.

III.                Credit quality of floating rate funds’ is somewhat similar to ultra short-term funds and liquid funds. Average maturity does not have much bearing on the performance of the floating rate mutual fund primarily because they invest in instruments which have a variable coupon rate.

When to invest in Floating Rate Mutual Funds?

When does the investor need to jump into the Floating Rate Mutual Fund bandwagon?  Here is a suggestion regarding the best time for investment:

I.                    One should invest in floating rate mutual funds when the interest rates are poised to rise.

II.                  Floating rate mutual funds are potent tools for building up emergency funds which can be useful during crisis.

III.                If the investor’s main concern is liquidity then they can go in for floating rate mutual funds as against FDs’ with bonds. A lot of exciting floating rate investment options is being launched each day. Recurring deposits offered by banks can now have a floating rate of interest which is reviewed and revised quarterly.

A Checklist for selecting good Floating Rate Mutual Fund

Investors may face a dilemma while trying to select a suitable fund according to their requirement. Here is a checklist for selection:

I.                    Performance wise long term floating rate funds are better geared than short term funds.

II.                  It is always better to select a fund which has proven credentials.

III.                Preference should be given to funds which invest higher percentage of asset in companies/securities with higher credit rating.

IV.                Select the fund with low expense ratio.

Conclusion:

It can thus be safely concluded that given the choice the best returns will come from long term floating rate mutual funds which performed consistently, are well invested and have a low expense ratio. While all investors may not be aware of the potential of Long term floating rate mutual funds, it is expected that this articles will help them to experience that sheer joy of receiving beyond expectation.

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company

        

A Guide to Choose the right Mutual Fund Scheme

“Models work when they are appropriate for the particular circumstance, but some of the best investment judgments over time have come when people recognized that models derived in other periods were broken or not directly relevant.”   Abby Joseph Cohen

Investing in mutual funds seems interesting, with number of websites, TV and other finance and wealth magazines publishing various information. However it is a challenging task and involves    knowledge regarding the shares and securities market and various laws that govern mutual funds is necessary before investing in them. Understanding the principle of mutual funds; the investment of the money of a large number of investors in stocks, bonds and money market instruments that are managed by managers makes one feel relieved.  However it is best for you as an investor to make a right choice of the mutual fund that suits your need.

Choosing right MF: 

Investment Objective & Time Horizon

The objective of the fund or the use to which the funds would be put to would be a vital deciding factor. Mutual funds investing in stocks would suit those that are ready to take more risks; stocks means more exposure to the volatile market though higher returns. The length of time that one has to wait to get reasonable returns also plays a vital role. So it is best to read the offer document or fund brochure carefully before making the decision.

             Liquidity:

In addition whether a fund is an open-ended or close ended one points out to how liquid your investment is. Open-ended funds are preferable to close ended ones as they can be converted to cash more easily than close ended ones that involve waiting for a period of time. Historically open ended funds have performed better than closed ended funds.

Diversification:

It pays to check for diversification in mutual funds, for an optimum diversification makes for a good choice. Opting for a diversification over 8 to 10 securities would be more risky than going in for diversification of 20 to 30 stocks. The diversification of stocks over 80 to 100 securities may mean difficulty of management to the fund manager. In addition making sure to ensure that there is a balanced diversification helps. 

Fund Performance:

After getting comfortable with the fund’s objective, it becomes equally important to know and analyze the fund’s performance. This involves looking at the fund’s short term and long term performance and comparing it with larger market indices or benchmarks like BSE Sensex and NSE Nifty. A higher market index over a longer period indicates better funds, however past performances in case of mutual funds can never be a guarantee of future returns and can serve only as an indicator.

Level of Risk:

The level of risk involved would be another important indicator, with higher returns available only at higher risk levels. Would you like to go for a low risk debt fund or to go for a moderate risk balanced fund or a high risk equity fund? Look before you leap.

Volatility & Consistency:

Next it is to be understood that any 2 funds giving the same return are not necessarily the same, as one fund could be more subject to market ups and downs than the other.  Volatile nature of funds is more a standard deviation meaning more risk involved. In the same category of funds, an investor needs to choose funds performing consistently.

Fund management:

The management of the fund plays an important role in deciding the best mutual fund for you, with professionalism being very important. The experience of the fund manager and the number of years he/she has been associated with the fund matters. With a new manager and frequent turnover are not good for investors.

Charges:

Things seem pleasant in mutual funds; however the charges like entry load, exit load, administrative charges and fund management charges on an annual basis are to be carefully looked into. It is significant to note that these charges cannot exceed 2.5% of the fund’s assets. Most funds have uniform charges, however hidden charges need to be looked into and carefully analyzed

To conclude mutual funds may be the best investments as they can be done in small amounts as compared to other types of investment and carry a comparatively lower risk. But your ultimate success in the form of good returns can only be assured with following these steps of smart mutual investment planning.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in  

Five Signs that Tell U Must Sell Mutual Funds

Start making the Decision:

It is vital for an investor, to have long-term investment plans.  But he needs to constantly verify if these funds are helping him to achieve his financial objectives. You, as an investor need to keep track of how your investments in mutual funds are growing. Also you need to make sure that you do not suffer huge losses due to non-performance.

As an investor you need to learn not only when to buy but also when to sell a mutual fund.  Learning the principles of when to sell a mutual fund helps weed off investment in unprofitable mutual funds and build up a desirable and profitable portfolio of mutual fund investments.

 

Look at situations to sell mutual funds:

 

Chronic Under-performer: 

Investor should stay invested for long tern in a risky asset class like equity. You should wait patiently for a minimum period of 5 years to watch your investments grow. Making comparisons between similar funds proves futile.

However you should make a note if your fund is continuously under performing. Comparing each of your funds with the respective fund benchmark index for various periods like 2 years, 3years and 5 years helps. You may need to move out of a continuous under performer and move in to a continuous performer.

Changes in Objectives of your Mutual Fund:

  

Next, an investor like you, investing with definite financial objectives with allocation to different sectors and market capitalization may feel uneasy and suspicious with the change in the fund’s objectives that exposed you to greater risk or risk in other sectors also.

Fund takeovers, change of ownership and mergers change the level of risk in a mutual fund portfolio. So you as an investor may find your need, not met and may want to sell the fund. This was the reason why many investors, who invested in UTI Mastergrowth Fund, sold their funds when it changed to UTI Top 100 Fund.

Repositioning of a Fund:

 

Though the fund has got an investment objective to invest in various market caps, so far the fund may be investing only in midcaps and positioned in the market as a large cap fund. But later, the fund may reposition the same fund as a multi cap fund and start investing in large cap stocks also. This change may not be a suitable one for an aggressive investor.

So as an investor, you need to be careful in watching the funds after investing. That too when a fund changes its positioning, you need to keep a close track of the same to prevent your investments from any adverse effect.

Appreciation in Investment Attained:

 It is quite possible that your investment could have been shrewd and calculated and achieved the targeted appreciation ahead of time. I congratulate you, but would like to tell you that greediness may also make you lose on that foresighted gain.  Selling off your fund in full or part and investing in safer avenues like debt funds, fixed maturity plans and fixed deposits of companies and in banks would safeguard your money yet give you some small return.

Say you wanted to accumulate Rs.10 lacs for the higher education of your daughter/son in 5 years time. Your investments have appreciated to 10 lacs at the end of 4 year itself. It is better to change it immediately to safe and non-risky investments. If you leave the investments in the same fund, it may come down in value because of the subsequent market fall.

So when the goal value has been reached, one needs to protect the appreciation by moving out from the existing risky investments and moving in to a safer investment.

 

Rebalancing based on the Asset Allocation: 

 

 As an investor you need to maintain an overall asset allocation ratio and you need to stick to it to gain more. Sometimes your investments have appreciated and this has increased the percentage of your portfolio in equity and maybe reduced the percentage on debt and other safe avenues.

You need to realize this means that you are exposing more of your investment to the volatile equity market that was risky. This could surely be remedied with rebalancing. That is selling a portion of the over appreciated asset and reinvesting the same in the lesser appreciated asset.

Selling funds to Achieve:

I am sure you would have understood these principles of when to sell a mutual fund. This will assist you in taking better investment decisions and achieving your financial goals.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Founder and Director of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in.

Mutual Fund SIP - Short Term or Long Term?

It may look very strange when everyone is advocating Mutual Fund SIP(Systematic Investment Plan) for long term, what is the necessity for this debate on ‘Is Mutual Fund SIP for Short term or long term?’.

Theoretically doing a Mutual fund SIP for long term will work for investors. But for practical reasons we need to commit a Mutual Fund SIP for short term. That is we need to break that long term into many 6 months or 1 year periods and commit your Mutual Fund SIP for first 6 month or 1 year.

Then at the end of 6 month or 1 year renew your SIP for another 6 month or 1 year. You need to renew like this till you complete your predetermined long term period.

You may think it is an unnecessary paperwork and waste of time. But you will be completely convinced when you have finished reading this article.

Contribution towards Mutual Fund SIP Changes:

How much you are contributing towards Mutual Fund SIP changes over a period of time.

Ø  At the beginning of a career a person will be able to commit Mutual Fund SIP for small sum of amount. As he progresses in his career, he or she will be able to increase his contribution towards Mutual Fund SIP.

Ø  Similarly, when someone reaches a stage where he need to spend more on kid’s higher education, daughter’s wedding, buying a house or meeting a major financial commitment, it is difficult for him to continue the same amount of Mutual Fund SIP contribution.

Ø  So whenever you renew your Mutual Fund SIP at the end of 6 month or 1 year, you can look at your cash flow position and based on that you can renew the Mutual Fund SIP for the increased amount or the same amount or the reduced amount.

Portfolio Review:

Also it gives you a chance to review your portfolio with your advisor once in 6 months or 1 year.

Ø  The scheme which you have chosen for Mutual Fund SIP is performing well when compared to its peers or not? You need to review this periodically. The scheme may turn out to be a laggard.

Ø  The scheme may be performing well when you have chosen for doing SIP. But over a period of time, it could have derailed from its performance. This is something like our cricket players. They will be in a good form in the game for some period of time. Then they will lose their form after sometime. So you need to periodically check up whether the fund is performing NOW or not.

Ø  If you are committing a Mutual Fund SIP for 10 years, then the advisor may not be coming back to you whenever you call him for reviewing your portfolio. If you commit for 6 months or 1 year he or she will be definitely coming to you for renewing the Mutual Fund SIP. You can have a review with him or her at that time.

When you commit Mutual fund SIP for long term, generally we ignore to review it. It may generate poor returns. You can avoid this by periodic review.

Equity Exposure in Overall Portfolio:

How much equity exposure you can give to your overall portfolio can change the amount of Mutual Fund SIP in equity and debt.

Ø  As the age goes up, your ability to take risk comes down. So you need to change your equity mutual fund SIP contribution periodically.

Ø  How close or distant you are to achieve your financial goals will also decide your equity exposure. If you have got long period to achieve your financial goal then you can have more equity exposure. When you have short period to achieve your financial goal, then you need to reduce your equity exposure.

Ø  Rebalancing your portfolio based on your predetermined asset allocation will also decide your equity exposure.

All this can change your Mutual Fund SIP amount in equity funds.

So committing a Mutual Fund SIP for long term looks good on paper. For practical reasons we need to commit for short term and renew it at the end of every short term till achieving our financial goals.

In this regard, instead of committing a Mutual Fund SIP just like that, having a long term financial plan and committing Mutual Fund SIP based on that plan will be really fruitful. This will make a solid difference in achieving your financial goals.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Founder and Director of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in.

Mutual Funds MythBuster

Rahul is working for a mutual fund house. They have recently came out with an NFO (New Fund offer). The day on which the fund house announced its maiden NAV (Net Asset Value), he received lot of calls from investors asking why the NAV is at below par. They thought something was wrong.

Then Rahul went on clarifying them that though both an equity fund and a stock extend market-related returns, there are some key differences between the two. If you have similar misconceptions about equity funds and stocks, this article will demystify all those misconceptions.

New Fund Offerings:

A new fund offer is not likely to generate amazing returns as can be the case with an initial public offering from a company.

This is because the NAV reflects the market value of the stocks held by the fund on any day. Because a fund holds several stocks in its portfolio, the NAV can only reflect the combined returns on the portfolio between the NFO date and the date of first NAV.

The first NAV declared by a fund can, at times, be lower than the par value of investment. A lower NAV does not mean a cheaper fund: Just because a New Fund is issued at Rs 10, it does not mean it has a chance of giving better returns than an existing fund that has a higher NAV.

Whether the scheme in which you are planning to invest has an NAV of Rs.15 or Rs.150 does not matter at all.

There is a difference between the price of a listed security and the NAV of a mutual fund scheme. Listed security has a price, determined by the demand and supply of the security. Whereas the unit's NAV of the scheme has a value determined mathematically, by the prices of the securities in the portfolio. If the portfolio appreciates by 10% Rs.15 NAV will become RS.16.5 and Rs.150 AV will become Rs.165. So in whatever the NAV you invest your investment will fetch you 10% return.

So instead of concentrating on LOW NAV and more number of units, it is worthwhile to consider other factors (performance track record, fund management, volatility) that determine the portfolio return.

A fund with higher NAV may give higher returns than a lower NAV fund, if its stocks did better in the markets.

Funds Vs Stocks

Point of distinction	Equity Fund	Stocks
Level of Risk	High	Highest
Entry/Exit cost	No Entry Load; But there will be Exit load. Advisory fee may be applicable.	Demat a\c and Brokerage charges
Options	Options available like dividend payout, dividend reinvestment, growth.	No such options
Minimum Investment	Min investment is usually Rs.5000.	Even one share can be bought.
Measuring Performance	Returns Vs Benchmark	Net Profit margins/EPS
Sub-division	Classified based on stocks in which it invests. (Diversified, Midcap, sectoral, thematic)	Classified as per the industry in which it operates.(FMCG, IT, PSU, METAL)
Pricing	Based on the price of the underlying securities	Based on the demand and supply of the particular stock

Dividends are not Extra Returns:

Immediately, after the dividend payment of dividend the NAV of the fund will fall to the extent of the dividend payment. Let us illustrate.

Fund’s cum dividend NAV is Rs.25. Proposed dividend is 50%. You are investing Rs.1 Lac and you will not get Rs.50000 as dividend. It is only Rs.20000 (50% on the face value Rs.10 is Rs.5 per unit) as the unit price is Rs.25 you will get 4000 units. Rs.5 dividend * 4000 units=Rs.20000.

And this dividend is not an additional gain or income. After payment of dividend the NAV of the scheme will fall to the extent of the payment and distribution taxes (if applicable). Now your NAV will become Rs.20 and your investment value will be Rs.80000 (4000 units * Rs.20 NAV).

In a nutshell,

Investment amount   Rs.1,00,000

Dividend amount     Rs.  20,000

Present Value      Rs.  80,000

It is nothing but investing Rs.80000 after dividend distribution at NAV Rs.20.

So investing in a scheme because it is declaring dividend in the near future is meaningless.

Usually a company with a liberal dividend policy may enjoy greater investor interest in the stock market. The same is not applicable to an equity-oriented mutual fund.

Investing more number of funds is not actual diversification. It may reduce your return.

Owning several mutual funds doesn’t necessarily broaden your holdings. It will be a mistake to buy the same securities over and over again in different funds with different names. You tend to believe they're diversified. But it is not real diversification.

There are only very few funds which are performing consistently. Instead of investing in few funds, if someone chooses to invest in more number of funds (because he intends to diversify) he may be forced to choose some average performing schemes also. As a result his returns will be diluted. The step taken by the investor to diversify his investment is not leading to diversification but to dilution of return.

Thus ideally your portfolio should not have more than four-five funds.

NO tax for churning:

When we buy shares and sell them within a year we are accountable for short term capital gain tax at the rate of 15%.

But mutual funds provide the benefit of churning of stocks with no tax implications. A fund which churns its portfolio within a year is exempt from tax because it only redistributes these profits to investors.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Founder and Director of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in.